Financial regulation and the deception of government intervention

From Deception of Government Intervention (1964) – an essay in Mises’ anthology Economic Freedom and Interventionism – we learn how governments adopted “the third way”:

Faced with the tremendous challenge of totalitarianism, the ruling parties of the West do not venture to preserve the system of free enterprise that gave to their nations the highest standard of living ever attained in history. They ignore the fact that conditions for all citizens of the United States and those other countries which have not put too many obstacles in the way of free enterprise are much more favorable than conditions for the inhabitants of the totalitarian countries. They think that it is necessary to abandon the market economy and to adopt a middle-of-the-road policy that is supposed to avoid the alleged deficiencies of the capitalistic economy. They aim at a system which, as they see it, is as far from socialism as it is from capitalism and which is better than either of those two. By direct intervention of the government, they want to remove what they consider unsatisfactory in the market economy.

Such a policy of government interference with the market phenomena was already recommended by Marx and Engels in the Communist Manifesto. But the authors of the Communist Manifesto considered the ten groups of interventionist measures they suggested as measures to bring about step-by-step full socialism. However, in our time the government spokesmen and the politicians of the left recommend the same measures as a method, even as the only method, to salvage capitalism.

In the aftermath of the financial crisis, we are now going down a road towards ‘judgement-based’ regulation of financial firms in an attempt to salvage capitalism.

It is proposed that firms will be supervised by what amount to shadow management teams of disinterested, public-spirited individuals more able to reach sound views than firms’ own management teams: they shall possess “the optimal experience and technical ability”.

Quite where these mythical philosopher kings are to be found, I do not know. Presumably, financial firms and regulators already hire the best people available. And the notion that the best people will work for the regulator despite inevitably higher rewards in the firms themselves is silly.

Financial firms will find their business subject to the day-to-day judgement of government officials. To think that those officials will be more capable than the institutions’ traders and managers is a fantasy. The outcome will be, as it has been, a surprise financial catastrophe as regulators fail to foresee the future and, since they are bound to converge on “best practice”, fail as one.

A free society is not one based on constant official interference with business. It is one based on cooperation, choice, competition, profit & loss, predictable rules fixed well in advance and exit from the market: that is, property, contract and the classical rule of law.

Rather than resort to fantastic ideas about the effectiveness of government interference with market phenomena, we would do better to reapply the principles of a free society. Financial institutions should be no exception, for government intervention caused the crisis [1,2].

Postscript: Marx and Engels’ ten measures are available here.


UK Think Tank Urges Radical Change To Financial Regulation, Says Axe The FSA

Over at, Tom Burroughes proposes a radical change to the way financial services are regulated in this country:

Much of the UK’s financial services industry does not need to be overseen by a single state regulator, and only banks linked to the payments system should be under such surveillance, according to a new report by the Institute of Economic Affairs, a free market think tank.

The report, called Does Britain Need a Financial Regulator?, challenges much prevailing opinion that has argued for tougher, more comprehensive rules and regulations to prevent a repeat of the recent market turmoil, affecting sectors including family offices. The US has recently signed into law sweeping regulations of banking and financial services; in the European Union, the bloc is moving to tighten oversight of hedge funds.

The IEA report is here (PDF). A briefing note to accompany it can be found on the IEA website.

Philip Booth, Editorial Director at the IEA and author of the report, “Does Britain need a financial regulator?” said:

“The market mechanism is enough to guarantee effective regulation: the number of financial scandals has not reduced in the era of statutory, bureaucratic regulation. Other than in the case of banks dependent on the Bank of England for deposit insurance and lender of last resort facilities, the financial system should be left to self-regulate.”

“If the coalition genuinely wants to create better regulation in the financial sector, along with more competition and cheaper capital for companies, they should scrap the FSA and the vast majority of its functions and leave the financial sector to itself as far as possible.”


Derivatives and Regulatory Failure – Precipice Bonds

Financial engineer Gordon Kerr presents the prequel to his article How to destroy the British Banking System – Regulatory Arbitrage via “Pig on Pork” Derivatives.

The 1997 Labour victory promised major changes to regulation and supervision of banks and the financial services industry. Shortly after Labour came to power I was working as a structuring engineer on the derivatives/securitisation desk at a big brand UK bank; I was aware of a few of the tricks of the trade, and I looked forward to rules being published that would no doubt tighten things up.

It soon became clear that the scope of the Financial Services Authority’s supervisory remit would grow. Regulators were gaining airtime and political clout, particularly in the aftermath of the 1998 collapse of Long Term Capital Management, a large US hedge fund set up by famous traders and derivatives specialists.

By early 1999 I began to realise that the actual regulatory function of the Financial Services Authority (FSA) was indeed changing; it was weakening markedly.

Relationships between bank staff and regulators were becoming friendlier, more personal. Actual supervision appeared to be widening but was in fact becoming less substantial. Greater weight appeared to be being placed on the bank’s “internal” regulatory function and I suspect that the FSA officers looked up to many of my internal colleagues. Why? Because I sensed the officers were just a little out of their depth. They needed help from the team of bank staff tasked with presenting our new structures to the regulators for approval.

Our internal teams that dealt with the regulators began to grow in confidence.
Continue reading “Derivatives and Regulatory Failure – Precipice Bonds”


Now State takes over bankers’ contracts – Telegraph

Via Now State takes over bankers’ contracts – Telegraph:

The new rules, which critics are likely to suggest amount to a State-enforced “incomes policy” for banks, will be contained in the Financial Services Bill to be announced in the Queen’s Speech.

The bill will give the Financial Services Authority (FSA) the power to cancel bankers’ contracts to prevent them receiving payments that it believes would cause instability in the financial system.

The FSA could stop bankers receiving bonuses that it believes are too high, or cancel remuneration packages that it thinks reward undue risk-taking.

It is hard to see this proposal as anything other than political posturing given the forthcoming election.  Are we to establish a new quango/ regulator “Ofpay”?  What will be the cost of that?  What access will individual bankers be allowed to their assessors?  How can the state decide which bankers have performed socially-useful functions and made positive contributions to the long term good of the bank concerned?  Working in a structured finance role in a dealing room environment is like being an MEP in the EU.  You have to be part of a team.  Management will only negotiate with voting blocs! One member of the team has to play the internal politics as in many other businesses, but this is of course an unproductive waste of time as far as shareholders are concerned.    How much more unproductive time will be spent trotting off to Ofpay to explain your achievements?

The root of the problem is the unreliable nature of banks’ reported profits. If the p&l was a sound number, surely the state could rely on employers to reward?  This news affirms my fear that the Government knows that the front-ending of prospective profits from derivatives trades and treating them as today’s “profit”, along with similar bank specific accounting wheezes, produce unreliable reported accounts.  That is the mischief the legislators should be focussing on.

Get that right and wages will look after themselves.

Further Reading